The Trillion-dollar Question Is, “When will this all end?”

…History tells us [see here for why that is the case] we should expect higher stock prices in the next quarter, mid-year, and by the end of 2018.The trillion-dollar question is, “When will this all end?”

To help answer this question, JP Morgan surveyed each of the major market tops and bear markets since the end of the roaring ‘20s and looked at four different variables related to the macro environment at the time:

recession,

a commodity spike,

an aggressive Fed,

and extreme valuations.

Below is a table of their results followed by an investigation of our own data into each of these bear market macro drivers.

Source: JP Morgan, Guide to the Markets

Bear Market Macro Driver #1 – The Risk of a Recession

As we often note, the most consistent macro driver of a bear market is a protracted economic slowdown, or recession. A visual inspection of declines in the S&P 500 going back to the Great Depression shows that most bear markets occur just prior to the onset of a recession (noted in red).

Source: Bloomberg, Financial Sense® Wealth Management

Our Financial Sense recession model monitors a wide variety of economic data and generally remains below 20 during economic expansions. We have had some close calls during this economic cycle but have not moved significantly above the 20-level threshold since the Great Recession of 2008. Furthermore, given our current reading of 12, it is highly unlikely that the bull market in stocks is in peril due to an imminent recession.

Source: Bloomberg, Financial Sense® Wealth Management

Bear Market Macro Driver #2 – Commodity Spike

The second macro driver associated with bear markets is a spike in commodity prices, particularly oil. As noted years back, oil’s relationship to the business cycle can’t be overstated...We can easily observe this by looking at the S&P 500 and oil’s year-over-year price movements going back to the early ’70s.

Source: Bloomberg, Financial Sense® Wealth Management

Barring some outside geopolitical event like an outbreak of war with North Korea or a conflict in the Middle East, I do not believe that oil will pose a significant threat to the present bull market and economic expansion for several reasons…

1.[As shown in the chart below], the U.S. is estimated to produce more oil than Saudi Arabia this year and is thus a greater marginal driver of oil prices. The stable increase in production by the U.S. should help keep global supply and demand dynamics in balance.

2. Another factor that is likely to keep a lid on oil prices is the slowdown we see in Chinese growth. Chinese real estate is very sensitive to moves in government interest rates and the rise in rates over the last year suggests that we should see a decline in Chinese real estate and GDP. A slowdown in China would also likely contribute to a cooling in global growth this year and help mute any oil price spikes.

Bear Market Macro Driver #3 – An Aggressive Fed

…There is a close relationship between past financial crises and Fed tightening cycles, something that we are in the beginning stages of currently.

Source: Bloomberg, Financial Sense® Wealth Management

The question is: how do you objectively gauge whether or not the Fed is aggressive? The easiest way to answer that is looking at where the Federal Funds Rate is relative to 10-year US Treasury yields.

When the Fed Funds Rate is above long-term yields, we have a negative spread between short and long-term rates, which is atypical and highlights points of financial tightness in the economy.

We see negative spreads often just before a recession begins, which is shown below where the Fed Funds rate is subtracted from the 10-year UST yield. Currently, the 10-yr UST yield is more than a full percentage point above the Fed Funds Rate, but that spread will narrow if the Fed raises rates three times this year per the consensus view.

Source: Bloomberg, Financial Sense® Wealth Management

For our own portfolio management process, an important metric we follow is the Federal Funds Risk Neutral Index, comparing Fed monetary policy to current market interest rates and real economic data, to help to gauge the relative tightness or looseness of Fed policy and the risk this poses to the market. As you can see below, the current policy stance is still relatively loose and not yet warning of an overly aggressive Fed.

Source: Bloomberg, Financial Sense® Wealth Management

Bear Market Macro Driver #4 – Extreme Valuations

The fourth macro factor often associated with bear markets is an extreme overvaluation of stock prices…During economic expansions, one asset class tends to outshine the others, whether it is bonds, stocks, real estate, or some other financial asset (think tech stocks in 2000 or housing in 2005) but [in] this cycle, everything seems to be increasing in value…

Looking at current household net worth relative to disposable income and also relative to nominal GDP shows we are at record extremes. As the Federal Reserve Bank of San Francisco points out, these ratios do not remain elevated for long and often come crashing down to their long-term averages. As such, today’s levels do pose a risk to the stock market and other financial assets in the years ahead, but do not serve as a near-term timing tool.

Source: Bloomberg, Financial Sense® Wealth Management

Summarizing the analysis above

The present bull market in stocks and economic expansion are likely to continue given we do not see any red flags suggesting its imminent demise…

Is this the “Mother Of All Blow-Offs?” Probably. Historically, this is the type of market behavior which has marked the blow-off top of speculative manias and has preceded serious market accidents. Chasing the price-momentum higher and waiting for a bigger idiot to buy shares from you works well until the music stops. Then everyone gets hurt.

2017 provided many good times but, for worriers, the low volatility and steady gains of last year signal bad times are likely in 2018 and they have a point. It’s true that good times can’t last forever. That being said, it’s also true that we can spot when the good times have gone too far with this simple indicator.

US stock market valuations appear stretched, but history reminds us that this form of excess can endure and, with the U.S. economy posting ongoing signs of growth, the market’s upbeat profile of late has macro support. Nonetheless, it’s prudent to consider how performance stacks up in terms of history.

As the next crisis erupts, the mainstream media is going to respond with shock and horror but the only real surprise is that this ridiculous bubble lasted for as long as it did. The truth is that a market decline is way overdue.

Right now most people seem to have been lulled into a false sense of security, and they truly believe that everything is going to be okay but every time before when the market has looked like this, a crash has always followed, and this time will be no exception.

The U.S. stock market has entered into the last stage, which I call the Super-Charged Tulip Mania. Not only are stock prices inflated well above anything we have ever seen before, but valuations are also reaching heights that are totally unsustainable. This next market crash will not resemble anything similar to what took place during the 2008-2009 U.S. banking and housing market collapse. When the markets cracked in 2008, EVERYTHING went down together. Instead this time around, as the markets tank the precious metals will surge to new highs.

Mark my words here: This third and final bubble (fourth if you count 1987) is now the biggest and most obvious bubble in this boom since 1983. It is as overvalued as at the top of 1929 and the fact that no one wants to hear about it is an ominous sign that it may well be peaking!

Treasury Secretary, ex-Goldman Sachs banker Steven Mnuchin, has threatened Congress with [a] stock crash if Congress doesn’t pass a tax reform Bill. His reason is that the stock market surge since the election was based on the hopes of a big tax cut. This reminds me of 2008.

If the markets crash in 2018 then, like previous crashes, they will prove to be a buying opportunity but, until the masses embrace this bull market, however, the most likely outcome is a correction and not crash.

Many people think that a huge crash is coming within the next 18 months. That being said, there are those who think that we will have a major ‘melt-up’ to 45,000 or 50,000 prior to a historical crash. Personally, I am uncertain which it will be and am waiting to discern what our Central Banks will do! Here’s why.

In this article we review the characteristics and different stages of a bubble, present some recent asset price bubbles, and identify current conditions which match up with traditional bubble criteria.

munKNEE.com to provide a fast & easy read. Take a look at what is happening in the bond markets which trade based on inflation in the real world. When inflation rises, bond yields rise and right now, sovereign bond yields are rising around the world.

The market is now officially in the largest bubble relative to the economy in history according to the stock market capitalization to GDP ratio, which, incidentally, is Warren Buffett’s favorite means of valuing stock.

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